Do banks really understand innovation?

By Stanley Epstein – Principal Associate at Citadel Advantage

Today’s “Financial Services Club Blog” on banks and innovation ( see: http://thefinanser.co.uk/fsclub/2009/07/sibos-1-why-banks-dont-get-innovation.html ) really got me thinking. Are banks really interested in innovation or are these “innovators” just few and far between?

When we speak about innovation it is not only technology. Innovations can come about without any technological advance. There is a distinction between “product innovation” and “process innovation”. In the former, the factors of production are rearranged in new, hitherto non-existent forms – no technology needed. “Process innovation” does tend to use advances in technology or new technologies – mobile payments are a case in point.

The underlying cause of financial innovation is self interest which manifests itself through the maximization of profits. Banks seek out, through the innovative process, the most efficient, cost effective way to maximize their profits either on existing products or potential new ones. Financial innovation comes about on the basis of anticipated material gain.

My feeling is that most banks don’t care about innovation at all. If a bank comes up with a new idea or process, and other banks feel that it can tag along to the benefit of their own bottom line, they will do so. In time a whole bunch of banks will do the same simply not to be left out. This is a simple application of the “Bandwagon” effect. And what is more many of these banks will have jumped onto the bandwagon without thinking the whole issue through, be it a new product or a new process. They simply don’t want to miss out, so they will “do it” at any cost. I have seen this time and time again.

The current financial mess that we are in and its precursor, the “sub-prime” debacle, is a case in point. Everyone was doing it. Profits were great. And no one gave much thought to even trying to understand either the product or the risks? Well, no one cared, and look where we are now.